Default danger: should investors be anxious after Argentina?

Despite Argentina defaulting on its debt for the second time in 13 years, economists claim this is likely to stay a local issue.

Last week Argentina defaulted on its debt following the failure of negotiations with ‘vulture’ bondholders. These are US hedge funds that bought cheap debt after the country’s 2001 economic crisis and demanded a full payout of US$1.3 billion, blocking Argentina to pay $539 million in interest to its restructured debt investors.

Shortly before the failure of the last-minute talks, Latin America’s third biggest economy was downgraded by ratings agency Standard & Poor to ‘selective default’ (SD) from CCC-.

The default is not expected to affect the Argentinian economy to the same extent as it did in 2001, but the impact can still be significant. Argentina has been isolated from global credit markets since 2001, but its public and private sector borrowing costs are now likely to rise further.

Argentina is not included in the MSCI and FTSE emerging market indices. MSCI downgraded the country to frontier market status in 2009, with FTSE following suit in 2010. Last year FTSE was considering a demotion of Argentina from frontier markets, including the country on its watch list.

Neil Shearing, chief emerging markets economist at Capital Economics, said the default’s effect on other emerging markets was likely to be limited and the uncertainty over the policies of the US Federal Reserve would have a more significant influence on those markets.

‘Yields on Argentine debt rose, as did credit default swap premia, but both are still below the peaks seen earlier in the year,’ he said. ‘Meanwhile, contagion to other emerging markets has been limited – EM equities and currencies have come under pressure over the past day or so, but this owes more to the shift in tone in Wednesday’s Federal Open Market Committee statement, which suggested that US policymakers are slowly becoming more hawkish.’

Shearing said the circumstances surrounding Argentina’s default were specific to the country and were unlikely to trigger a wider emerging market sell-off.

‘We expect EM currencies and foreign currency bonds to come under further pressure over the coming months, but this is mainly due to the shift towards tighter policy in the US,’ he added.

He said the default did not come as a complete surprise and was probably already priced in. But he also pointed out there were now more challenges ahead for the country. ‘The economy was already in recession prior to default and the negative hit to sentiment, coupled with a more general tightening of financing conditions across the economy, add to the headwinds facing the recovery. Against this backdrop, we wouldn’t be surprised to see a further rise in foreign currency bond yields, as well as another devaluation of the official exchange rate.’

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